Financial literacy is one of the most important
skills to learn in today's world. However, it's not one that's always thoroughly
talked about in schools, though we are slowly but surely improving on that front as time
goes on. However that's not going to be of much help
to those of us who have already left school. Thankfully the proliferation of blogs, podcasts,
YouTube channels, and other outlets have given people easy ways to learn more about finance
outside of the traditional education system. Today I'm going to show you why that is so
important. Let's talk about just how big a difference
becoming financially literate can be for your life. So what is financial literacy? The dictionary definition would define financial
literacy as the possession of the set of skills and knowledge that allows an individual to
make informed and effective decisions with all of their financial resources. In more plain English, it is the ability to
figure out what financial decisions are likely to lead you to achieving your financial goals
and having the ability to act on that knowledge. So how do we become financially literate? Assuming that you did not get enough financial
education in school you will need to take things into your own hands. You do this by exposing yourself to new ideas
from as many different people and perspectives as you possibly can. Read books, take classes, watch videos or
look at blogs related to money just like you are now. Any of these can have very positive effects
on your financial situation both in the present and future. They can introduce you to new ideas that you
may not have come across on your own. These may lead to you saving or making more
money or even finding new passions. These outlets can reassure you during uncertain
times that the world isn't coming to an end and this too shall pass. This can be particularly helpful during less
than ideal times. They can give you encouragement when things
are going well and help keep you motivated to continue working towards your goals. And perhaps most importantly (especially if
you're just starting out and didn't get much financial education when you were growing
up) they can introduce you to so many new possibilities that get you excited about researching
finance. That'll get you thinking about what you can
accomplish in your own life with your own resources. Before we get into an example showing how
big of a difference even a moderate level of financial literacy can make let’s discuss
some statistics relating to the average American budget. Some light rounding has been done, but this
should give us a general idea of what the typical American spends money on. According to data gathered by the Bureau of
Labor Statistics’ Consumer Expenditure surveys, the average American household spends almost
$20,000 a year on housing costs. These costs include mortgage or rent payments,
utilities, maintenance and repairs, property taxes, and other related fees. The median price of a home is approximately
$300,000. The average rent for a 1 bedroom apartment
nationwide is $950. 2-bedroom apartments will run close to $1,200
a month. Transportation is the next largest category
and it costs the average American about $9,000 annually. These costs include fuel, maintenance, repairs,
public transit, plane tickets, and other related transportation expenses. Food costs about $4,000 and dining out costs
about $3,150. Healthcare costs about $4,600 a year. That includes health insurance as well as
prescription medication, doctors visits, and other health-related expenses. We spend around $2,500 a year on personal
care and clothing. The clothing portion of that cost also includes
related services such as tailoring and dry cleaning. We also spend almost $3,000 a year on various
forms of entertainment like cable, concerts, movies, and subscription services. Insurance costs can vary widely depending
on your level of coverage and what type of insurance you’re looking for, but here are
some rough averages. Renter’s insurance will run you about $180-$200
a year. Homeowners insurance averages between $1,000-$1,100
a year. Term life insurance averages around $2,000
a year and whole life policies can be upwards of $5,000 annually. However, like I said those can vary quite
a bit depending on what you’re going for. Finally, giving and miscellaneous expenses
amount to around $2,000 and $1,000 a year respectively. The reason I bring these statistics up is
its what we’re going to be basing most of the expenses of our first couple on. In this example, we’re going to be looking
at two couples who have just graduated high school and are looking to start college at
the end of the summer. They will both start with no debt to speak
of and will be able to work all summer before starting college. They will both earn the same amount of money
from their jobs before, during and after school. In both cases, they will be earning $12/hr
from their summer and school jobs and will have $60,000 a year in household income from
salary after graduation. As for other expenses, they will each be getting
new cars once every 7 years. Our first couple will be buying new cars while
our second couple will get their cars used. Both couples will be getting homes, but our
first couple will be lucky enough to receive a full down payment as a gift from their parents
while our second couple will have to save for the down payment themselves. Where saving money is concerned both couples
will try to have enough money on hand to purchase their next cars outright. However, as you’ll see this won’t be possible
all the time. The down payment money will also go into savings
for our second couple. The money that is put into savings will earn
2.5% in interest. The rest of the money that doesn’t need
to be spent or saved will be invested. Money invested will be earning 8% in interest. There will also be a dollar-for-dollar match
for the first $1,800 invested each year. This equates to roughly 3% of our couples
salaries. The net worth of each couple will be determined
by how much they have saved and invested. It will not include the value of their home,
but I will mention those at the end separately. With that out of the way, let’s get into
the example and see just how big of a difference financial literacy can make on our lives. Bill and Mary have just graduated from high
school and are looking to go to college. As I mentioned, they will work the summer
after graduating from high school and during college for $12/hr. During summers they work full time and during
the school year, they work 20-hours per week. Therefore Bill and Mary make about $10,000
the summer before college and $31,200 a year combined while going to school. Once Bill and Mary graduate they will get
new jobs that each pays $30,000 a year for a total household income of $60,000 annually. Bill and Mary attend 4-year universities in
state which cost them about $25,000 per year to attend. These numbers are based on averages gathered
by valuepenguin.com. The $25,000 per year includes all tuition,
fees, books, and other expenses relating to their education. Between food, transportation, and the occasional
fun night out Bill and Mary spend an additional $850 a month. Therefore in total, they spend just over $60,000
a year while in school. Four years go by and unfortunately for Bill
and Mary they racked up a lot of student debt. All told, they will graduate with over $100,000
in student loans. Assuming 4.5% interest their student loan
payments will be over $1,000 a month! After graduating from college, Bill and Mary’s
budget looks similar to the average American budget in most respects. They spend around $20,000 in housing costs,
$9,000 on transportation, $4,600 on healthcare, $2,500 for clothing and personal care, a little
over $7,000 for food and dining out, and about $1,000 for miscellaneous expenses. In total, they spend everything they make. However, there are still a few things worth
noting. First is their insurance bill. They will spend about $6,000 a year for all
their insurance. This is because they have a whole life insurance
policy (which is generally more expensive dollar for dollar than term life), pay homeowners
insurance (which is generally more expensive than renter’s insurance since there’s
more to cover), and have two cars to insure. Another thing to notice is that they aren’t
doing any charitable giving, saving, or investing because they can’t afford to with their
other expenses. Lastly, their entertainment budget is essentially
zero. They had to cut that in order to make their
debt payments each month. Unless they were to find some other source
of income or slash their current expenses somehow, this is likely to be how they live
for the next several years. At the age of 33 Bill and Mary’s student
loans are finally paid off. As a result, their expenses drop to about
$50,500 a year. This also means that they can finally increase
their entertainment budget. I’m going to assume that from this point
forward they spend right about the average of $3,000 a year on entertainment. 20 years later at the age of 53, their home
is paid off which drops their housing cost significantly. Based on their $240,000 mortgage and assuming
a 3.85% interest rate (which is right about average as of the time of this writing) for
a 30-year loan, Bill and Mary's annual expenses will fall to about $39,750 a year. 40 years after graduating high school Bill
& Mary will have a paid-for home. They will no longer be financing their cars
and will have a net worth of $75,000. Additionally, they bought their home for $300,000
with the help of their parents 34 years ago. They haven’t moved since, which is pretty
unusual but it certainly has helped them financially. Assuming the value of their home grew by 3%
per year their home would be worth $820,000 today. So between their savings, investments, and
home, they are worth a whopping $895,000! That’s pretty good considering they carried
so much debt that they couldn’t save for the first several years of their careers. But how much better could they have done if
they played their cards a little differently? Let's find out by comparing them to John and
Jane. John and Jane may not have all the answers
but they have researched personal finance and investing. They have learned enough to make some different
choices than Bill & Mary did. The first difference comes in the form of
where they go to school. Bill and Mary graduated high school and went
straight to a 4-year University. John and Jane decide to get their first two-years
done at a local community college. As it turns out this is a lot cheaper. According to data from valuepenguin, the average
cost of a community college is $4,800 per year. Therefore, John and Jane will be spending
$9,600 per year between the two for their first two years of college. They will then transfer to a 4-year university
to complete their bachelor’s degree just like Bill and Mary. This will cost them the same $25,000 per year,
per person like it did for Bill and Mary. In total, their college education will set
them back almost $120,000. That’s certainly a lot, but it’s far more
manageable than the $200,000 than Bill and Mary spent on their education. Assuming their non-education expenses and
incomes were the same as Bill and Mary, John and Jane would graduate with about $20,000
in student loans. However, this is where we see the second difference
between the path Bill & Mary took and the one John and Jane are taking. John and Jane noticed that their salaries
weren’t going to be able to pay for their college in full so they decided to start researching
how to make money outside of a job. They learned about side hustles and eventually
started one where they flip items on places like the Facebook marketplace for a profit. They net about $12,000 from this side hustle
and since it doesn’t take much time they will continue doing it after graduation. John and Jane graduate and get jobs that pay
them a combined $60,000 a year. With their side hustle, this makes their household
income $72,000 annually. However, the differences between John and
Jane’s working life and that of Bill and Mary’s doesn’t stop there. John and Jane want to supercharge their finances
while they’re young and able to get the most out of compounding interest. There’s also something to be said about
spending more of their money on things that they care about most. As a result, they decide to save on big-ticket
items like housing and transportation. John and Jane don’t buy a house right after
graduating from college. They make good money but haven’t had a chance
to finish paying off their student loans or save up a good down payment yet. However, they still want to keep their housing
costs down, so they find some roommates to get an apartment with. As I said earlier, the average rent for a
2-bedroom apartment nationwide is a little under $1,200 a month. If we assume John and Jane split the costs
evenly with their roommates and also assume that utilities and other apartment related
expenses adds another $400 a month onto the total housing costs then John and Jane’s
portion of the costs will be $800 a month. $800 a month for housing costs is $9,600 a
year which is about $10,000 less than the typical American pays for shelter. To save money on transportation, John and
Jane buy one used car for the two of them and they buy it with cash. This will mean that they have to look for
carpooling options to work, either with coworkers or by taking turns dropping each other off,
but for now, that’s okay with them. The next time they're shopping for cars they
can get one for each of them. This strategy actually accomplishes a couple
things. First, they only have one car to repair and
maintain. And second, they only have one car to pay
insurance on. Statistically speaking, the average American
household has about 2.6 cars. So I don’t think it’s beyond belief that
John and Jane could cut their transportation costs in half with this strategy. With the insurance and transportation savings,
this strategy keeps approximately $5,000 a year more in John and Jane pocket when compared
to Bill and Mary. The last strategy John and Jane use to save
money is to limit the amount of times that they eat out. As I said, the average American spends over
$3,000 a year eating out and $4,000 on groceries. By limiting their dining out expenses John
and Jane’s total food costs come out to about $5,000 a year. While most of the money John and Jane saved
with these strategies go toward their investments, some will go to savings and other things. John and Jane will need to save $20,000 every
7 years to pay for their new cars and will need $60,000 for a down payment on their future
$300,000 home. The home will be on a 15-year mortgage with
an interest rate of 3.3% (once again the rough average for 15-year mortgages as of this writing). The monthly payment will be just shy of $1,700. We had Bill and Mary get their home right
out of college at the age of 23. I will have John and Jane get their house
at the age of 27 since that’s when they would’ve saved up enough to make the down
payment. They will also rent out their unused rooms
to help offset the cost of housing. Their rental income is assumed to be $500
a month. John and Jane will be spending $1,700 a year
on entertainment (which is the average amount spent on entertainment minus the expense of
cable). They will be giving $2,000 to causes they
believe in. And they will also be investing $2,000 a year
toward their kids' future college fund starting when he or she is born and continuing until
he or she turns 18. The investments will be in an ESA for their
son or daughter can withdraw the money for college tax-free. I’m going to assume that their child is
born the year they move into their new home. Everything else will be kept the same as it
was in Bill & Mary’s example. Based on this scenario John and Jane would
have their home paid off when by the time they’ve turned 43. This will lower their annual expenses by about
$20,400 a year. Two years later their son or daughter will
graduate high school with over $80,000 sitting in his or her college fund. This means that John and Jane no longer need
to save money into the ESA which’ll lower their annual expenses by an additional $2,000. And 40 years after John and Jane graduated
high school they have a paid-off home, a kid who has graduated college mostly, if not entirely,
debt-free, and a whopping $4,500,000 to their name. Their house was originally valued at $300,000
when they bought it 30 years ago. Assuming the value of their home grew by 3%
per year their home would be worth $728,000 today. So between their savings, investments, and
home, they are worth a whopping $5,228,000! That’s over five times the net worth Bill
and Mary ended up with. And John and Jane have set themselves up for
a sweet retirement. Based on the 4% rule their $4.5 million dollars
would give them a $180,000 a year income for the rest of their life! That’s how important becoming financially
literate is. And that’s why I and so many others like
me online try to teach it. We’re very fortunate here in America that
we can live a pretty comfortable life even if our decisions weren’t ideal or if we
got a late start like Bill and Mary did with their savings. But we also have an amazing opportunity to
set ourselves up for an extraordinary life both now and in the future if we take the
time to learn about how money works and how we want
to work with money.
